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J. JOSEPH CURRAN,JR. Attorney General NORMAN E, PARKER. JR. CARMENM. SHEPARD Deputy Attorneys General
STATE OF MARYLAND
OFFICE OF THE ATTORNEY GENERAL
TELECOPIER No WRITER'S DIRECT DIAL No.
(410)576-6393
(410)576-7292
July 8, 1996
Frank Broccolina, Deputy State Court Administrator Robert C. Murphy Courthouse Annapolis, Maryland 21401 Dear Mr. Broccolina: You have requested advice concerning the Internal Revenue Code (hereinafter "Code") provisions requiring tax returns for income earned on "designated settlement funds." More specifically,you ask whether the Code provisions and applicable regulations apply to moneys being held by the clerksof court in special interest bearing accounts relative to pending litigation. For the following reasons,I haveconcludedthat the Code provisionsand regulations do not apply to moneys held by the clerks. The United StatesCode provides specialtax rules for income earned on designated settlement funds. 26 U.S.C. §468B. This Code section defines "designated settlementfund" as: any fund-(A) which is established pursuant to a court order and which extinguishes completely the taxpayer's tort liability with respect to claims described in subparagraph(D), (B) with respectto which no amount may be transferred other than in the form of qualified payments, (C) which is administered by persons a majority of whom are independentof the taxpayer, (D) which is establishedfor the principal purpose of resolving and satisfying present and future claims against the taxpayer (or any related person or formerly related person) arising out of personal injury, death, or property damage, (E) underthe termsof which the taxpayer(or any related person) may not hold any beneficial interest in the income or corpus of the fund,
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(F) with respectto which an electionis made under this section by the
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200 Saint Paul Place.
Baltimore,
Maryland 21202-2021
Telephone Numbers: (410) 576-6300 .D.C,
Metro 470- 7534
Telephonefor Deaf: (410) 576-6372
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Frank Broccolina, Deputy State Court Administrator July 8, 1996 Page 2 taxpayer. The regulationsadoptedto implementthis Code provision clarify that a designated settlement fund includesone agreed upon by the parties to litigation and approved by the court, as well as one ordered by the court. SeeReg. §1.468B-1(c)(1). The regulations further clarify that the litigation that results in the court ordered or approved settlement fund may arise "out of tort, breach of contract, or violation of law." SeeReg. §1.468B-1(c)(2)(ii). A qualified settlementfund is subject to tax on the "modified gross income;" income generally does not include the money or property transferredto the fund by the defendantto satisfy the liability for which the fund is established. See Reg. §1.468B-2(a) and (b). An income tax return must be filed for each taxable year by the "administrator" of the fund. SeeReg. §1.468B-2(k)(3). The settlement funds contemplated by this Code provision and the regulations are those generallyestablished approvedby court order to satisfy multiple claims in large tort law suits such or as the asbestoslitigation by individual plaintiffs who suffered asbestosisor airplane crash litigation by the families of deceasedpassengersor any injured survivors, or to compensate victims of violations of federal or state laws such as securities laws. Examples of litigation set forth in the regulations include: (1) a class action against a corporation for violation of the securities laws in which the court holds the defendantcorporation liable for $150 million in damages;and (2) a class action againsta corporation for tort liabilities in which the court finds the corporation liable for $50 mi~lion in damages. To satisfy such numerous or large claims, the defendants transfer money or property or both into settlement funds that often are managed by court appointed or approved trustees to handle liquidation of any property and paymentof the claims over time. Money held by the clerks in custodialegispendingresolutionof disputed claims do not qualify as "settlement funds." Examples of litigation in which the clerks hold moneys in special interest bearing accounts include condemnationcasesand interpleader cases. In a condemnation case,the government deposits with the clerk the amount the government is willing to pay for the property being condemned, the sufficiency of which amount is being disputed by the property owner. In interpleader cases, clerkshold moneysfor which adverseclaims are being litigated. For example, the a sellerand buyer of real property maydispute entitlement the deposit, the seller claiming the buyer to forfeited the deposit and the buyer claiming entitlement to return of the deposit. In such a case,the real estatebroker holding the depositmay paythe disputed money into court pursuant to Rule 2-221 pending resolution of the adverse claims. In either of these types of cases,the clerk deposits the moneyinto the bank, in a specialinterestbearingaccountif so directed by the court, pursuant to Rule 1214. The moneys held by the clerk are held during the pendency of the litigation, not after resolution of the disputes by court imposed or approved settlement, which settlement totally extinguishesthe defendant's liability.
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Frank Broccolina, Deputy State Court Administrator July 8, 1996 Page 3 When settlement occurs in a large class action or in other litigation involving in a sizeable amount of damages, a settlement fund may be establishedto satisfy the claims. The defendant transfers money or property or both to the settlementfund, which is to be administered by persons the majority of whom are unrelated to the defendant. Such a settlementfund would never be held by or administered the clerk of court. As stated above, it is the "administrator" of the fund who, by by law, must file the annualtax return reporting gross income. If you have any further questionsregarding this matter, pleasedo not hesitate to contact me.
Sincerely,
f4 /.:4-) ;r /~C
Julia M. Freit Assistant Attorney General JMF/s
Enclosure